David Elms, Head of Diversified Alternatives, believes that 2019 could mark the end of the ‘Goldilocks’ period. He discusses what this might mean for investors and where new opportunities might form.
What key theme is likely to shape markets in 2019?
I am probably not alone in thinking that a background of increased volatility will be an important feature of both equity and fixed income markets in 2019 and that searching for investments that help diversify away from these traditional asset classes will be high on investors’ agendas. However, as we have witnessed during 2018, providing portfolio diversification has been challenging for many alternative managers. The key to success in 2019, in our view, will be in providing an attractive return while having little or no beta to traditional assets.
We have had artificially low volatility underpinned by the easiest monetary conditions since the phrase “geopolitics” was originally coined by Swedish political scientist Rudolf Kjellén at the turn of the twentieth century. While this has certainly helped resurrect economic growth from the ashes of the Great Financial Crisis (GFC), we are now starting to see this stimulus withdrawn from the economy.
I would argue that many of the lessons that should have been learned from the GFC have been ignored, or ‘kicked down the road’, due to this period of cheap money. The leverage effect has fuelled the price of risk assets, benefiting equities, and put a cap on interest rates, benefiting bonds. I see 2019 as a period where this ‘Goldilocks’ scenario could change.
What does this mean for investors?
This is not revolutionary thinking. Investors have known about the effect of this stimulus, they just have not needed to do anything about it. In fact, delaying any asset allocation away from risk assets has hitherto been profitable and the best decision. At some point, however, that will change. I believe the question investors should be asking is: “where do I seek diversification?”
If the lessons of the two sharp drawdowns we have witnessed during 2018 are anything to go by, this diversification is hard to come by. During these periods of increased market stress, we have seen returns from many alternative asset managers correlate highly with the drawdowns in equities, and - on both occasions in 2018 - this has occurred after a sharp rise in interest rates. As such, alternatives as an asset class have not generally delivered on their aim of offering diversification.
What are the opportunities for alternatives in 2019?
The opportunities for 2019 lie in providing strategies that genuinely help our clients manage their investments through this uncertain time. Within the Diversified Alternatives Team at Janus Henderson, we continuously focus on delivering attractive risk-adjusted returns with little or no equity or fixed income beta. We search for what is known as ‘convexity’ in our portfolios: strategies that have a positive correlation to volatility. So far in 2018, this has worked and we look forward to providing clients with investments that have little or no beta to traditional assets in 2019.
Which themes have the potential to redirect markets in 2019? Download our Infographic to find out
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